Question

a) Explain the impact of leasing transaction on the financial statements of the lessee according to the current accounting standard for leasing (IAS 17). Support your answer with an appropriate numerical example.

Answer 1

In the current regime of IAS 17, lease is recorded as either financial lease or operating lease. Operating lease does not record any asset or liability (though mentioned in notes to the financial statements) and is directly expensed as lease payments in income statement. Where as under financial lease, lessee records assets at inception and take depreciation deduction. ​Further, lessee records the entire rental payments as a liability at inception and reduces it through each rental payment.

Example

On 1 April 2017 Trump Co entered into an agreement to lease a machine that had an estimated life of four years. The lease period is also four years, at which point the asset will be returned to the leasing company. Annual rentals of $5,000 are payable in arrears from 31 March 2010. The machine is expected to have a nil residual value at the end of its life. The machine had a fair value of $14,275 at the inception of the lease. The lessor includes a finance cost of 15% per annum when calculating annual rentals. How should the lease be accounted for in the financial statements of Bush for the year end 31 March 2018?

Solution

The lease should be classified as a finance lease as the estimated life of the asset is four years and Trump retains the right to use this asset for four years in accordance with the lease agreement therefore enjoying the rewards of the asset.

Initial accounting: recognise the asset and the lease liability

Dr Property, plant and equipment 14,275

Cr Finance lease obligations 14,275

Subsequent accounting:

Dr Depreciation expense 3,568 ($14,275 / 4 years)

Cr Accumulated depreciation 3,568